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Cost Management-final                                                                                                       15

Industry Structure Analysis : Michael Porter developed a five factors model a way to organise information about an industry structure to evaluate its potential attractiveness.

Under this model, the profitability of an industry or market — measured by the long-ten

return on investment of the average firm — depends largely on five factors that influence


Factors which influence profitability are :


Bargaining power of buyers;


Bargaining power of suppliers;


Threat of substitute products or services;


Threat of new entrants; and


Intensity of competition

1. Bargaining power of buyers : The degree of buyer power generally depends on : — customer concentration (the higher the concentration of customers, the greater is the negotiation leverage);

-the propensity for customers to integrate backward (the higher the propensity for back-ward integration, the greater the bargaining leverage);

-costs of switching suppliers (the lower the switching costs, the greater the buyer's leverage); and

-the number of alternative suppliers (the greater the number, the greater the customer's leverage).

2. Bargaining power of suppliers : Just as powerful buyers can squeeze profits by putting sward pressure on prices, suppliers squeeze profits by increasing input costs. The same factors that determine the power of buyers also determine the power of suppliers. The bargaining power of suppliers and buyers relative to the firm depends on the relationships between their value chains. Bargaining power will be a function of relative strengths, in particular value activities that depend on one another.

Identifying the specific activities involved and the nature of their strengths and relationships important insights into the power balance between buyer and seller, and how it may be altered for the firm's benefit.

3. Threat of substitute products or services : The potential for profit in an industry is mined by the maximum price that customers are willing to pay. This depends primarily on the availability of substitutes. When few substitutes exist for a product— e.g., gasoline consumers are willing to pay a potentially high price. If close substitutes for a product t, then there is a limit to what price customers are willing to pay. Any price increase will cause some customers to switch to substitutes. A thorough understanding of the value us of buyers as they relate to the firm's product can help in assessing (and combating) threat of substitution.

4. Threat of new entrants : If an industry is earning a return on invested capital above the cost of capital, that industry will act as a magnet to firms outside the industry. Unless the entry of new firms is barred, the rate of profit must fall to the competitive level. Even the mere threat of entry may be sufficient to ensure that established firms constrain their prices to the competitive level.

5. Intensity of competition : Markets experiencing rapid growth typically see less intense petition. Rival companies can usually satisfy profitability and growth without having to market shares from their competitors.

The variety and nature of the value chains of competitors shape many of the characteristics a industry. The relative importance of economies of scale versus economies of scope, sample, depends on the kind(s) of technology employed in competitors' value chains, stability of the

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